Chapter 21 Forms of Business Organization 2019 Mc

Chapter 21 Forms of Business Organization © 2019 Mc. Graw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of Mc. Graw-Hill Education. 1

Major Forms of Business Organizations • Sole Proprietorship. • Corporation. • General Partnership. • S Corporation. • Limited Partnership. • Limited Liability Company. • Limited Liability Partnership. © 2019 Mc. Graw-Hill Education. 2

Sole Proprietorship • Definition: Unincorporated business owned by one person. • Owner has total control. • Owner has unlimited liability. • Profits taxed directly as income to sole proprietor. © 2019 Mc. Graw-Hill Education. 3

Advantages and Disadvantages of Sole Proprietorship Advantages: • Ease of creation (“start-up”). • Owner has total managerial control. • Owner retains profits. Disadvantages: • Personal liability for all business debts/obligations/losses. • Funding limited to personal funds and loans. © 2019 Mc. Graw-Hill Education. 4

General Partnership • Definition: Unincorporated business owned and operated by two or more persons. • Each partner has equal control of business. • Each partner has unlimited, personal liability for business debts/obligations/losses. • Profits taxed as income to partners. © 2019 Mc. Graw-Hill Education. 5

Advantages and Disadvantages of Partnership Advantages: • Ease of creation (“start-up”). • Partnership income is partner income. • Business losses qualify for tax deduction. Disadvantages: • Personal liability for all business debts/obligations/losses, including those incurred by other partners on behalf of partnership. © 2019 Mc. Graw-Hill Education. 6

Termination of Partnership • Occurs through “Dissolution” Stage and “Winding Up” Stage. • Dissolution (Definition): Change in relation of partners caused by any partner’s ceasing to be associated with carrying on of business. • Winding Up (Definition): Completing unfinished partnership business, collecting and paying debts, collecting partnership assets, and taking inventory of business. © 2019 Mc. Graw-Hill Education. 7

Reasons for Rightful Dissolution of a Partnership 1 • The term established in the partnership agreement expires. • The partnership meets its established objectives. • A partner withdraws from the partnership at will. • A partner withdraws in accordance with the partnership agreement. • A partner is expelled from the partnership in accordance with the partnership agreement. • A partner dies. • A partner is adjudicated bankrupt. © 2019 Mc. Graw-Hill Education. 8

Reasons for Rightful Dissolution of a Partnership 2 • The business of the partnership becomes illegal. • A partner is adjudicated insane. • A partner becomes incapable of performing the duties as established by the partnership agreement. • The business of the partnership can be carried on only at a loss of profits. • A disagreement between the partners is such that it undermines the nature of the partnership. • Other circumstances of the partnership necessitate the dissolution. © 2019 Mc. Graw-Hill Education. 9

Limited Partnership • Definition: Unincorporated business with at least one general partner, and one limited partner. • General partner in limited partnership has managerial/operational control over business. • Limited partner’s liability limited to extent of his/her capital contributions. • Limited partner has no managerial/operational control over business. © 2019 Mc. Graw-Hill Education. 10

Limited Liability Partnership • Definition: Partnership in which all partners assume liability for any partner’s professional malpractice to the extent of the partnership’s assets. • If one LLP partner is guilty of malpractice, other partners’ personal assets cannot be seized. • Business name must include phrase “Limited Liability Partnership” or abbreviation “LLP. ” • Parties must file form with Secretary of State to create LLP. • Each partner pays taxes on his/her share of business income. © 2019 Mc. Graw-Hill Education. 11

Corporation • Definition: State-sanctioned business with legal identity separate and apart from its owners (shareholders). • Owners’ (shareholders’) liability limited to amount of investment in corporation. • Profits taxed as income to corporation, plus income to owners/shareholders (“double-taxation”). • “S” Corporation can avoid double-taxation. © 2019 Mc. Graw-Hill Education. 12

Advantages and Disadvantages of Corporation Advantages: • Limited liability for shareholders. • Ease of raising capital by issuing (selling) stock. • Profits taxed as income to shareholders (not partners). Disadvantages: • “Double-taxation. ” • Formalities required in establishing and maintaining corporate existence. © 2019 Mc. Graw-Hill Education. 13

“S” Corporation • Definition: Business organization formed under federal tax law that is considered corporation, yet taxed like a partnership. • Incorporated under state law and then granted S Corporation status by the IRS so that income can be passed through to shareholders. • No more than one hundred shareholders. • Shareholders must report income on their personal income tax forms. © 2019 Mc. Graw-Hill Education. 14

Limited Liability Company (LLC) • Definition: Business organization with limited liability of a corporation, yet taxed like partnership. • Formed under state law. • Owners of LLC (“members”) pay personal income taxes on shares they report. • No limitation on number of owners permitted in L LC. © 2019 Mc. Graw-Hill Education. 15

Specialized Forms of Business Organizations 1 • Cooperative—Organization formed by individuals to market products. • Joint stock company—Partnership agreement in which company members hold transferable shares, while all company goods are held in names of partners. • Business Trust—Business organization governed by group of trustees, who operate trust for beneficiaries. © 2019 Mc. Graw-Hill Education. 16

Specialized Forms of Business Organizations 2 • Syndicate—Investment group that forms for purpose of financing specific large project. • Joint Venture—Relationship between two or more persons/corporations created for specific business undertaking. • Franchise—Agreement between “franchisor” (owner of trade name/trademark) and “franchisee” (person who, by specific terms of agreement, sells goods/services under trade name/trademark). © 2019 Mc. Graw-Hill Education. 17

Advantages and Disadvantages of Franchise (To Franchisee) Advantages: • Assistance from franchisor in starting franchise. • Trade name/trademark recognition. • Franchisor advertising. Disadvantages: • Must meet contractual requirements, or possibly lose franchise. • Little/no creative control over business. © 2019 Mc. Graw-Hill Education. 18

Advantages and Disadvantages of Franchise (To Franchisor) Advantages: • Low risk in starting franchise. • Increased income from franchises. Disadvantages: • Little control (except contractually) over individual franchise. • Can become liable for franchise, if franchisor exerts too much control. © 2019 Mc. Graw-Hill Education. 19

Types of Franchises “Chain-Style” Business Operation: • Franchisor helps franchisee establish a business (using franchisor’s business name, and franchisor’s standard “methods and practices”). Distributorship: • Franchisor licenses franchisee to sell franchisor’s product in specific area. Manufacturing Arrangement: • Franchisor provides franchisee with technical knowledge to manufacture franchisor’s product. © 2019 Mc. Graw-Hill Education. 20

Question for Discussion 1 • Corporations are a relatively recent way of doing business. As little as 150 years ago there were very few corporations. Most businesses were sole proprietorships or partnerships. In recent years corporations and now LLCs and LLPs account for most businesses. All of these business forms insulate the owners from liability. Is it really in the public interest to insulate business owners from the debts and liability of the business? © 2019 Mc. Graw-Hill Education. 21

Question for Discussion 2 • What form of business is best for a small family owned business or a new enterprise formed by two friends and just getting started? Discuss the pros and cons of forming the business as a corporation, S corporation, partnership, LLP, or LLC. © 2019 Mc. Graw-Hill Education. 22

Question for Discussion 3 • In a corporation, there is usually one vote per share so a majority shareholder, especially in a small corporation controls the business. In contrast in a co-op there is one vote per member. Most co-ops are small member controlled businesses, but some are large entities. What co-ops can you find? Do you belong to any? What sorts of businesses are suited to this form of business entity? © 2019 Mc. Graw-Hill Education. 23